Friday, April 25, 2014

According to the complaint (PDF), Robert J. Vitale and Realty Acquisitions & Trust, Inc. "fraudulently raised at least $8.7 million from investors through four real estate securities offerings" by making "materially false and misleading statements and omissions concerning, among other things, the credentials and experience of Vitale and other purported RATI officers, Vitale's supposed reputation for honesty..., the safety of investing in RATI, and the ownership of the properties purchased with RATI investor proceeds." Additionally, Vitale allegedly acted as an unregistered broker and violated a "2006 Commission Order that barred him from association with any broker or dealer." The SEC has charged the defendants with violating various provisions of the Securities Act and Exchange Act and seeks disgorgement, prejudgment interest, and civil penalties. The SEC also seeks disgorgement and prejudgment interest from relief defendant Coral Springs Investment Group, Inc.

Vitale was "sentenced in September 2013 to two years in prison after being convicted of obstruction of justice and providing false testimony in the investigation that led to the SEC case filed today."

A final judgment as been entered against Gurudeo Persaud for allegedly violating antifraud provisions of the securities laws. The final judgment enjoins him from future violations and orders him to pay over $126,000 in disgorgement and prejudgment interest. " The Commission dismissed its civil penalty claim against Persaud, who pled guilty to charges in a parallel criminal case, was ordered to pay restitution of $948,340 to his victims, and is currently serving a three-year prison sentence."

According to the complaint (PDF), Keith A. Seilhan traded on insider information concerning the magnitude of BP's oil spill and the fact that "BP's potential liability and financial exposure, was likely to be greater than had been publicly disclosed." Seilhan learned of this information when he was tasked by BP "with coordinating BP's oil collection and clean-up operations in the Gulf of Mexico and along the coast." The insider trading "allowed Seilhan to avoid losses and reap unjust profits as the price of BP securities dropped by approximately 48 percent." Seilhan has consented to a final judgment that permanently enjoins him from future violations of the securities laws, and orders him to pay over $224,000 in disgorgement, prejudgment interest, and a civil penalty.

According to the complaint (PDF), "TelexFree, Inc. and TelexFree, LLC claim to run a multilevel marketing company that sells telephone service based on "voice over Internet" (VoIP) technology but actually are operating an elaborate pyramid scheme." The complaint also charges TelexFree co-owner James Merrill,...TelexFree co-owner and treasurer Carlos Wanzeler,...TelexFree CFO Joseph H. Craft,...and TelexFree's international sales director, Steve Labriola" as well as "four individuals who were promoters of TelexFree's program: Sanderley Rodrigues de Vasconcelos,...Santiago De La Rosa,...Randy N. Crosby,...and Faith R. Sloan." The SEC has secured an asset freeze against these companies and seeks permanent injunctions, disgorgement, prejudgment interest, and civil penalties. The SEC has also named TelexFree Financial, Inc., TelexElectric, LLLP, and Telex Mobile Holdings, Inc. as relief defendants and seeks disgorgement and prejudgment interest from them.

According to the complaint (PDF), Wayne Pennoyer Weddington III and his companies, Brunswick Capital LLC and Brunswick Capital Partners LP, have been charged "with solicitation fraud, making false statements, and registration violations in connection with a commodity pool that he formed called Pennoyer International Funds Global Opportunity LLC." The CFTC "seeks civil monetary penalties, trading and registration bans, and a permanent injunction against further violations of the federal commodities laws, as charged."

An Order (PDF) was issued last week filing and settling charges against Derek J. Bridges and his companies, Empire Sterling Metals Corp. and I.P.M. Investments, Inc., "for engaging in illegal, off-exchange precious metals transactions." These financed metal transactions were executed through Hunter Wise Commodities, LLC. The Order "requires Bridges and Empire jointly to pay restitution totaling $243,456.61 and Bridges and I.P.M. jointly to pay restitution totaling $14,854.41 to their customers." The Order also "imposes permanent registration and trading bans on Bridges, Empire, and I.P.M."

Previously, the CFTC sued Hunter Wise in December 2012 "charging it with engaging in the same type of illegal, off-exchange precious metals transactions engaged in by Empire and I.P.M. through Hunter Wise." This year, "the court entered judgment against Hunter Wise for engaging in illegal precious metals transactions."

Thursday, April 24, 2014

Earlier this week we posted the summary results of our investigation into the performance of 27 non-traded REITs which had had a liquidity event by December 31, 2013. We found that investors are $27.7 billion worse as a result of investing in these 27 REITs rather than investing in a diversified portfolio of traded REITs. The post is available here.

Figuring out this $27.7 billion shortfall required a tremendous amount of work - far more than required to determine the relative returns of most of investments.

First we determine the amount and timing of investments into each non-traded REIT by investors unaffiliated with the REIT. These investments are purchases of shares directly and additional purchases through dividend reinvestment programs. We next determine the cash flows back out to investors in the form of redemptions and cash distributions not reinvested. We then apply the flows in an out of the REIT to the Vanguard Real Estate Index Fund (Ticker: VGSIX). Information on this fund can be found at the Vanguard website by clicking here. On the liquidity date, we compare the value of unaffiliated investors’ holdings in the non-traded REIT with the value of what they would own if the same inflows and outflows had been made on the same dates in the VGSIX. $27.7 billion is the difference between what investors would have had if they had invested in traded REITs and what they did have as a result of the non-traded REIT investment.

For example, here’s how we concluded unaffiliated investors lost $3.2 billion by investing in the Columbia Property Trust (“Columbia”). You can download an Excel spreadsheet with all our data and calculations for this REIT by clicking here.

Columbia began selling shares to investors on November 26, 2003, so the first fiscal year ended December 31, 2003. We gathered each 10-K thereafter until Columbia was listed on the NYSE in 2013 and the three 10-Qs Columbia filed in 2013 before it is listed. The 10-Ks can be downloaded by clicking here; the 10-Qs can be downloaded by clicking here.

Columbia began selling shares to investors on November 26, 2003, so the first fiscal year ended December 31, 2003. We gathered each 10-K thereafter until Columbia was listed on the NYSE in 2013 and the three 10-Qs Columbia filed in 2013 before it is listed. The 10-Ks can be downloaded by clicking here; the 10-Qs can be downloaded by clicking here.

For each filing, we ask three questions.

How much cash did non-affiliated investors put into the REIT during the period?

How much cash did those same investors receive from the REIT during the period?

When did the cash flows happen during the period?

Cash Flows in Fiscal 2003

You can find the Columbia Property Trust (“Columbia”) financial statements for fiscal 2003 by clicking here. The Statement of Cash Flows shows $1,000 was raised from an equity sale. Note 1 in the Notes to the Financial Statements says the cash is from an affiliated advisor, which means we will record it but ultimately don’t want to include it in our results since we are trying to determining how unaffiliated investors fared. There were no other cash inflows from investors, and there were no cash outflows to investors reflected on the 2003 10-K.

Columbia’s 2003 10-K also provides some helpful background information. For example, Columbia has a Dividend Reinvestment Plan (“DRP”) which gives investors the option of re-investing their dividends rather than receiving the dividends in cash. Columbia also has a Share Redemption Program (“SRP”) under which investors can sell shares back to the trust, subject to several restrictions. Specifically, the trust will redeem shares for less than investors paid and will not spend more redeeming shares than it receives from selling DRP shares. Although Columbia frequently changed the rules in future years, some version of both of those restrictions survives.

Cash Flows in Fiscal 2004

Columbia’s 10-K for fiscal 2004 is here. The Statement of Cash Flows has more activity than the prior year, and raises some questions. We’ll go through the capital activity and related questions one at a time.

1. Columbia raised $792,012,000 selling stock.Who bought the shares?

We do not find any reference to shares purchased by affiliates or related parties so we assume all of the shares were purchased by non-affiliates.

Is the dollar amount net or gross of fees?
Both the Statement of Cash Flows and Note 1 in the Notes suggest the amount is gross of fees. That is good, because when we compare investments we want to track all cash paid by investors, not just the part of their cash that was invested in real estate.

2. Columbia spent $690,000 to redeem stock. Was the stock redeemed under the SRP?
According to Note 1, the stock was redeemed “pursuant to [Columbia’s] share redemption program.” Notice in Note 6 that the SRP has changed and now cannot be more than 50% of the DRP proceeds in the current calendar year.

Where is the related DRP activity?
Remember, the SRP is limited by the amount of DRP activity. So if Columbia spent $690,000 to redeem stock, investors must have purchased at least $1,380,000 worth of stock through the DRP. There is no mention of DRP activity in the 10-K, but after digging around we find some useful information in the 3Q 10-Q here. The 10-Q does not directly report DRP activity, but it does report something called “Redeemable Common Shares.” It turns out that Redeemable Common Shares are the difference between proceeds from DRP shares in the current year and proceeds spent on SRP shares in the current year (see the discussion of Stockholders’ Equity in Note 6). This means that, as of September 30, 2004, DRP proceeds are equal to Redeemable Common Shares plus money spent through the SRP. Although we cannot use this method to calculate DRP activity for the entire year, we know that $3,923,000 of Columbia’s dividends in the first three quarters of the year was paid by issuing more shares to investors.

3. Columbia paid $16,613,000 to investors as dividends.Is the dollar amount cash paid, or does it include the dividends paid as DRP shares?

We know that at least $3,293,000 of dividends was reinvested as DRP shares. Neither the Statement of Cash Flows nor the Statement of Stockholders’ Equity for fiscal 2004 has a separate category for issuance of common stock from the DRP, so it must be that the “Issuance of Common Stock” includes shares issued through the DRP. If that line item includes DRP proceeds, the only way for the Statement of Cash Flows to tie out is for dividends to include DRP shares. This means that investors received no more than $13,320,000 in cash from dividend payments. They likely received less, but we cannot tell how much of the 4Q dividend was paid in DRP shares.

In summary, the 10-K for fiscal 2004 suggests that investors contributed $788,719,000 and received no more than $14,010,000.

Finally, we assume that non-affiliated investors use the DRP and SRP programs in the same proportion as affiliated investors. Thus, some of each year’s DRP and SRP activity is attributed to affiliated investors in proportion to the number of shares held by affiliated investors at the end of the prior fiscal year.

Cash Flows in Fiscal 2005-2012

We follow the same process for fiscal 2005 and 2006 that we used for 2004. Beginning in 2007, we no longer need to estimate how many shares were issued through the DRP. Although the 2007 financial statements do not present the number of DRP shares, the 2009 financial statements (link) include the number of DRP shares for fiscal 2007 and 2008. We can therefore directly calculate proceeds from the issuance of common stock (excluding DRP shares) and cash returned to the investor via dividends and SRP shares (excluding dividends paid through DRP shares). In fiscal 2013, we use 10-Q’s because Columbia is listed shortly after the end of 3Q.

Table 1 presents our estimate of how much cash non-affiliated investors put into the trust and how much cash they received in each year. Unaffiliated investors paid $5.19 billion for Columbia shares, received $976 million in cash dividends and $676 million in sales proceeds for a net investment of $3.54 billion at the time of the liquidity event.

Table 1. Cash contributed by and received by non-affiliated investors in each fiscal year (in millions).

To check the reasonableness of our calculations, we collect the same data points in number of shares instead of dollar amounts and calculate how many shares were held by non-affiliated investors. We then compare our calculation to the number of shares held by non-affiliated investors as sometimes reported in small print at the beginning of the 10-K. We do not expect to get the same number, because the REITs definition of non-affiliated investors does not necessarily match ours, but we should be close. The fiscal 2012 10-K reports that non-affiliates held 547,081,420 shares as of June 30, 2012. Our estimate is 547,161,436 as of December 31, 2012, which is quite close.

The next step is to determine when the cash flows happened during the year. This is difficult, as the 10-K’s only provide one data point per year. We improve our estimates of the timing of cash inflows by examining 424b3’s filed by Columbia between the 10-K filings. The 424b3 filings can be found by clicking here. These forms are filed sporadically when they are filed at all, often disclose total gross proceeds accumulated from the first capital raise to a specified date in the 424b3. Between the dates for which cash inflows are known (424b3 and 10-K dates), we assume that cash is invested in the trust evenly over time. This is equivalent to assuming that the cash is invested at the average price during the intervening time period.

Cash outflows are comprised of two components: dividends and stock repurchases. The timing of dividend payments is fairly easy to estimate; Columbia’s 10-Ks indicate that the dividend is paid quarterly. In Columbia’s case, the dividend paid each quarter is disclosed on a table in the 10-K. For REITs that disclose total dividends for the year rather than each dividend payment, we assume that the dividend is the same in all four quarters (or twelve months, as appropriate).

The second component of cash outflows is share repurchases. Share repurchases are only reported in financial statements, so we assume that the share repurchases happen evenly between financial statement filings.

The Liquidity Event

We estimate how much could be realized by non-affiliated investors by multiplying the liquidity event price by the number of shares held by non-affiliates in the immediately preceding SEC filing. This assumes all investors could have sold their shares on the first day of the first liquidity event, even though the liquidity event often only allows some of the shares to be liquidated. We read press releases to determine when the liquidity event first happens, and then use either press releases or historical pricing data to determine how much each share was sold for in the liquidity event.

After all of this analysis, we finally have what we are looking for: the cash into and out of the non-traded REIT over time, incorporating proceeds, distribution reinvestment, redemptions, distributions, and transactions with affiliated entities. This is a lot of work, but it allows us to directly compare the returns that investors have realized versus a diversified, liquid, low-cost benchmark. When we apply the daily net investment (the amount of cash that actually went to or came from the non-affiliated investor) to the Vanguard Real Estate Index Fund (Ticker: VGSIX) for the 27 non-traded REITs that have had liquidity events, we find that investors would have been $27.7 billion better off without non-traded REITs.

Unaffiliated investors in the Columbia REIT had shares worth $3,030,135,756 at the liquidity event on October 10, 2013. Investors had paid $3.54 billion net of dividends received and redemption proceeds for these shares and so suffered an out of pocket loss of $500 million. If these investors had instead put their money – in the same amounts on the same dates – in liquid, traded REITs they would have had investments worth $6,238,578,884. They would have had an out of pocket gain of $2.7 billion instead of an out of pocket loss of $500 million. Thus investors lost $3,208,443,128 as a result of being sold this non-traded REIT instead of traded REITs.

Tuesday, April 22, 2014

As part of our effort to help investors avoid non-traded REITs, we have written over 25 blog posts on this defective investment type. We have noted in our research that because of high costs, illiquidity, lack of transparency and conflicts of interest, non-traded REITs should underperform liquid, low-cost traded REITs. A number of our blog posts including our post on the early trading in NYRT last week (here) have calculated the amount investors are worse off as a result of being in the non-traded REIT instead of a diversified portfolio of traded REITs.

Research on how investors fared in non-traded REITs is extremely difficult because non-traded REITs’ SEC filings report approximate offering proceeds accumulating during offerings which may last many years. We are not aware of any prior thorough analysis of what returns investors have earned in non-traded REITs. In this vacuum of hard evidence, self-interested commentary has continued to tout non-traded REITs as a reasonable - even preferable - alternative to traded REITs. Over the next several weeks, we are going to roll out the result of our in depth investigation of the returns retail investors have experienced in non-traded REITs.

We report the results of our analysis first for the non-traded REITs that have had a “liquidity event” or gone through the “full life-cycle.” This bit of industry jargon means the REIT has listed and secondary market trading commenced or the REIT has merged into a traded REIT or another non-traded REIT which provided some option for investors to cash out their shares. These REITs tend to be non-traded REITs whose real estate portfolios have generated enough income and increased in value sufficiently to pay for distributions and for the extraordinarily high embedded fees charged by non-traded REITs.

The figure shows that the 27 non-traded REITs that have merged or listed raised $46.1 billion through their public offerings and dividend reinvestment programs.

Table 1 reports the $20 billion investors have lost as a result of investing in non-traded REITs which have had a liquidity event. Despite the lack of liquidity and diversification, investors in 26 of the 27 non-traded REITs that have listed or merged as of 2013 had lower returns than if they had just invested in a liquid, diversified portfolio of traded REITs. Bringing forward the shortfalls as of the liquidity event date to the present at the returns to traded REITs, the shortfall grows to $27.7 billion.

Non-Affiliated
Market Value

Traded REIT
Value

Investor
Shortfall

03/31/2014
Investor Shortfall

American Realty Capital Trust

$1,849,907,910

$1,950,567,631

$100,659,722

$125,556,940

American Realty Capital Trust III

$2,181,360,606

$1,859,630,077

-$321,730,529

-$342,935,495

Apple Hospitality Five

$635,143,847

$958,051,639

$322,907,791

$395,621,092

Apple Hospitality Two

$324,867,758

$427,904,165

$103,036,406

$131,101,668

Apple REIT Six

$990,043,660

$1,059,835,974

$69,792,314

$66,746,728

Apple Residential Income Trust

$191,231,451

$268,679,140

$77,447,689

$359,633,328

Apple Suites

$126,566,319

$133,426,415

$6,860,096

$23,622,504

Carey Institutional Properties

$401,526,083

$564,562,660

$163,036,578

$357,643,381

Chambers Street Properties

$2,252,754,748

$3,511,343,162

$1,258,588,414

$1,181,501,133

CNL Hotels & Resorts

$3,038,854,733

$6,350,162,608

$3,311,307,876

$4,021,241,309

CNL Restaurant Properties

$680,005,539

$1,065,937,895

$385,932,355

$768,260,928

CNL Retirement Properties

$3,542,272,538

$4,573,620,858

$1,031,348,320

$1,367,163,261

Cole Credit Property Trust II

$1,943,996,975

$2,065,865,797

$121,868,823

$122,443,183

Cole Real Estate Investments

$5,231,595,947

$6,183,374,278

$951,778,331

$1,063,832,310

Columbia Property Trust

$3,030,156,886

$6,239,214,010

$3,209,153,584

$3,444,148,812

Cornerstone Realty Income Trust

$254,208,226

$318,734,387

$64,526,161

$309,435,270

Corporate Property Associates 10

$83,582,547

$289,471,540

$205,888,992

$652,445,523

Corporate Property Associates 12

$383,575,577

$646,043,518

$262,467,941

$322,920,945

Corporate Property Associates 14

$718,165,015

$1,272,151,746

$553,986,732

$704,500,480

Corporate Property Associates 15

$1,284,912,635

$1,829,100,903

$544,188,269

$626,778,728

DCT Industrial Trust

$1,803,254,885

$1,838,784,948

$35,530,064

$56,794,819

Independence Realty Trust

$408,135

$490,239

$82,104

$88,562

Inland Real Estate Corporation

$716,865,321

$786,928,683

$70,063,361

$169,379,981

Inland Retail Real Estate Trust

$3,367,679,161

$5,154,656,330

$1,786,977,169

$2,129,299,523

Piedmont Office Realty Trust

$2,467,221,472

$4,805,014,852

$2,337,793,380

$4,669,612,842

Retail Properties of America

$1,594,391,201

$5,707,293,635

$4,112,902,434

$4,968,962,498

Whitestone REIT

$9,935,955

$22,024,199

$12,088,245

$19,323,063

TOTAL

$39,104,485,130

$59,882,871,291

$20,778,482,621

$27,715,123,318

These losses relative to traded REITs are a predictable result of the extraordinary offering costs and ongoing conflicts of interest in non-traded REITs which are largely absent in traded REITs. Table 2 reports the estimated embedded fees charged by the sponsor in each non-traded REIT brought forward to the liquidity date alongside investors’ shortfall for each REIT.

Non-traded REIT

Embedded Fees

With Real Estate Returns

Investor Shortfall

American Realty Capital Trust

$208,652,000

$246,449,000

$100,660,000

American Realty Capital Trust III

$202,322,000

$226,168,000

-$321,731,000

Apple Hospitality Five

$60,194,000

$142,387,000

$322,908,000

Apple Hospitality Two

$31,757,000

$84,855,000

$103,036,000

Apple REIT Six

$117,741,000

$243,556,000

$69,792,000

Apple Residential Income Trust

$34,419,000

$33,064,000

$77,448,000

Apple Suites

$14,703,000

$18,544,000

$6,860,000

Carey Institutional Properties

$37,907,000

$114,111,000

$163,037,000

Chambers Street Properties

$280,442,000

$493,379,000

$1,258,588,000

CNL Hotels & Resorts

$370,117,000

$957,884,000

$3,311,308,000

CNL Restaurant Properties

$90,661,000

$218,475,000

$385,932,000

CNL Retirement Properties

$313,160,000

$636,991,000

$1,031,348,000

Cole Credit Property Trust II

$244,359,000

$376,016,000

$121,869,000

Cole Real Estate Investments

$547,823,000

$778,019,000

$951,778,000

Columbia Property Trust

$628,023,000

$1,067,307,000

$3,209,154,000

Cornerstone Realty Income Trust

$30,420,000

$39,571,000

$64,526,000

Corporate Property Associates 10

$8,684,000

$34,953,000

$205,889,000

Corporate Property Associates 12

$34,007,000

$153,127,000

$262,468,000

Corporate Property Associates 14

$85,126,000

$274,593,000

$553,987,000

Corporate Property Associates 15

$124,524,000

$341,326,000

$544,188,000

DCT Industrial Trust

$183,014,000

$221,236,000

$35,530,000

Independence Realty Trust

$58,000

$61,000

$82,000

Inland Real Estate Corporation

$72,597,000

$142,040,000

$70,063,000

Inland Retail Real Estate Trust

$255,772,000

$702,272,000

$1,786,977,000

Piedmont Office Realty Trust

$578,211,000

$906,795,000

$2,337,793,000

Retail Properties of America

$515,646,000

$874,609,000

$4,112,902,000

Whitestone REIT

$3,359,000

$3,452,000

$12,088,000

TOTAL

$5,073,700,000

$9,331,240,000

$20,778,483,000

Additional posts over the next three weeks will detail our calculations and explore other aspects of non-traded REITs which should make them per se unsuitable given the widespread availability of lower risk, higher return alternatives.

Last week, Steven Palladino was charged with 25 counts of criminal contempt "based on his repeated violations of Court orders obtained by the Commission in its civil action against Palladino and his...company, Viking Financial Group, Inc." The SEC's 2011 complaint alleged that the defendants "were operating a fraudulent Ponzi scheme." The United States Attorney's office has charged the defendants with "'knowingly and wilfully disobey[ing]' Court orders in the Commission's action that froze all of Defendants' assets, required that Defendants deposit all funds in their possession into a court-ordered escrow account, and required Palladino to purge himself of a prior order of civil contempt." Palladino, "who is currently serving a prison sentence based on convictions in state court for the same Ponzi scheme activity, could face additional incarceration" if convicted of these charges.

According to the complaint (PDF), Timothy J. Coughlin "and two entities that did business as 'Oxford International Credit Union' or 'Oxford International Cooperative Union'...conduct[ed] an Internet offering fraud in which investors lost millions of dollars by investing funds in a fictitious credit union. " The SEC alleges that "Coughlin misappropriated investor money to pay personal expenses, fund unrelated business expenses, and make distributions to other investors in a classic Ponzi-scheme fashion." The complaint charges the defendants with violating various provisions of the Securities Act and the Exchange Act and seeks disgorgement, prejudgment interest, civil penalties, conduct-based injunctions, "and an officer-and-director bar against Coughlin." Additionally, the SEC "seeks disgorgement and prejudgment interest from relief defendants American Quality Cleaning Services, Inc. (d/b/a 'Oxford Privacy Group') and Avocalon LLC." A criminal complaint has been unsealed against Coughlin in a parallel action.

A final judgment was entered by consent against Robert C. Rice, who allegedly with other defendants "defrauded investors of more than $1.8 million" by supposedly offering "direct investments in fraudulent trading programs involving 'bank guarantees,' [and] promising sky-high returns with guarantees against loss." The final judgment permanently enjoins Rice from future violations of the securities laws, and orders him to pay over $525,000 in disgorgement, prejudgment interest, and a civil penalty. Previously, the court entered final judgments against "211 Ventures, LLC, and Robert S. Anderson, imposing judgments totaling more than $2.3 million in disgorgement, prejudgment interest and civil penalties, and permanently enjoining both defendants from future violations of the antifraud and other provisions of the federal securities laws." The SEC's cases against "Diane Glatfelter and K2 Unlimited, Inc. continues."

Thursday, April 17, 2014

The non-traded REIT, American Realty Capital New York Recovery REIT, Inc., renamed New York REIT, became a listed REIT this week. It opened at $10.70 and closed at $10.75 on April 15, 2014. Yesterday, April 16, 2014, it closed at $10.55 and today it closed at $10.62. We’ve posted extensively about the evils of non-traded REITs. You can find those previous posts here.

The April 16, 2014 Wall Street Journal’s “New York REIT Starts Fast” quotes Nicholas Schorsch as saying the first day’s close of $10.75 was a “victory” and reflected the “most successful” of his listings. You would think from his comments that investors in the non-traded REIT had done well but that is not the case.

Based on NYRT’s $10.62 closing price, the value of the $1.5 billion invested while NYRT was non-traded is $1.82 billion. We estimate that retail investors in this REIT have experienced returns greater than what they would have earned in Vanguard’s liquid, diversified mutual fund of traded REITs (VGSIX), they are about about $100 million less than what they would have earned investing in the traded REIT which also focuses its investments in New York, SLG, over the same period.

Figure 1 shows our estimate of the value of retail investors’ investments in American Realty Capital New York Recovery REIT had they instead been made in SLG. The three red dots are the values of those investments at NYRT’s closing price for its first three days of trading.

Investors who suffered through years of illiquidity and lack of transparent pricing with the non-traded REIT ended up doing much worse than they would have if they had purchased a traded REIT with the same New York real estate concentration. We think the relative performance of NYRT relative to SLG is going to get worse. Most of NYRT’s capital was raised and properties purchased were in 2013. Since then New York real estate prices have increased 8% according to a source quoted in the WSJ article. Given the 11.5% upfront fees (nearly $200 million) on this non-traded REIT, NYRT should still be worth less than $10.

So, how does a high-cost, defective investment like American Realty Capital New York Recovery REIT, Inc. become listed to some fanfare? Figure 2 is a screenshot of SLG and VGSIX during the period NYRT was raising most of its money.

During this period, New York real estate values were increasing more rapidly the diversified real estate holdings. Rising New York property values allowed this non-traded REIT to invest $8.80 or less per $10 investors paid into real estate and have that $8.80 plausibly grow to $10 within a year. Of course, investors would be much better off if all of their $10 investment had been invested in this real estate.

The increase in New York real estate relative to diversified portfolios of real estate in recent years illustrated in Figure 2 is only the sunny side of the lack of diversification. Extending the time period back a little we see the enormous decline in the value of an undiversified investment in New York real estate in 2008 and early 2009.

This week’s NYRT listing must be welcome relief for investors who were trapped in the previous, non-traded incarnation. Unfortunately, it may well lead to even more sales of non-traded REITs in the future. In the near future, we will be posting the results of our extensive investigation which shows the non-traded REIT industry has destroyed at least $25 billion of investor wealth over the past 10 years.

Richard T. Posey, former Vice-President of Carter's, Inc., has been charged with trading "based on inside information that he possessed as a result of his position at Carter's, and...tip[ping] material nonpublic information to the company's former Vice-President and Director of Investor Relations, Eric M. Martin." Posey consented to the entry of an order that enjoins him from future violations of the securities laws, orders him to pay $60,625 in disgorgement and prejudgment interest, and permanently bars him from acting as an officer and director of a public company.

This week the SEC filed an "emergency action to halt a Ponzi scheme conducted by JCS Enterprises, Inc., T.B.T.I. Inc., and their respective principals Joseph Signore...and Paul L. Schumack II." The SEC alleges that from 2011 through the present, the "defendants fraudulently raised at least $40 million from hundreds of investors nationwide through the ongoing sale of investments in Virtual Concierge machines." The complaint charges the defendants with violating various provisions of the Exchange Act and Securities Act and seeks disgorgement, prejudgment interest, civil penalties, and "any other relief that may be necessary and appropriate." In a parallel action, criminal charges have been announced against Signore and Schumack.

According to the complaint (PDF), CVS Caremark misled "investors about significant financial setbacks and us[ed] improper accounting that artificially boosted its financial performance." Allegedly, the "improper accounting adjustments were orchestrated by Laird Daniels, who was the retail controller at CVS." Daniels has been "charged with accounting violations in a related SEC administrative proceeding." Daniels has agreed to settle these charges by paying a $75,000 penalty and agreeing to a one year bar from practicing as an accountant "on behalf of any publicly traded company or other entity regulated by the SEC." The SEC has charged CVS with violating provisions of the Securities Act and Exchange Act. CVS consented to a final judgment that orders it to pay a $20 million penalty, and permanently enjoins it from future violations of the securities laws.

According to the complaint (PDF), Matthew D. Sample raised almost $1 million through his hedge fund, The Lobo Volatility Fund, LLC, and then "fraudulently diverted approximately one-third of the money for his personal use and to make payments to other investors." Sample has consented to a permanent injunctions from future violations of the securities laws and from "directly or indirectly soliciting or accepting funds from any person or entity for any unregistered offering of securities." The SEC also seeks disgorgement, prejudgment interest, and civil penalties against Sample.

A final judgment was entered against Mia Baldassari who allegedly "received $24,500 in investor funds to which she had no lawful claim." The final judgment orders that "she is liable for disgorgement of $24,500, and that such amount shall be deemed satisfied from funds she deposited into the court’s account." Last month, the Court dismissed "relief defendant Brett A. Cooper from the action." Cooper is "now a principal defendant in a separate enforcement action," SEC v. Brett A. Cooper, et. al., "alleging that he and several of his companies perpetrated fraudulent investment schemes from 2008 to 2012. "

The CFTC "filed and settled charges against three companies and their owners for engaging in illegal, off-exchange precious metals transactions, and requires that the Respondents jointly pay more than $940,000 in restitution to their defrauded precious metals customers." The first CTFC Order (PDF) found that PGS Capital Wealth Management, PGS Capital Credit, Inc., and their owner, Charles Victoria "unlawfully solicited retail customers to buy and sell off-exchange precious metals, such as gold and silver, on a financed basis." The second CTFC Order (PDF) found that Rockwell Asset Management, Inc and its owner, Frank O. Davies "unlawfully solicited retail customers to buy and sell off-exchange precious metals, such as gold and silver, on a financed basis." The Orders also found that "customers sent the deposit, finance charge, and commission to PGS and Rockwell, respectively, who then confirmed the transaction and ultimately transferred the funds to Hunter Wise Commodities, LLC, whose existence was not disclosed to the customers." Hunter then allegedly "remitted $462,727.50 back to the PGS companies and Victoria, and $477,210 back to Rockwell and Davies, as their respective portions of the customers’ commissions and fees for the retail financed precious metals transactions executed through Hunter Wise." In 2012, the CFTC sued Hunter Wise "charging it with engaging in illegal, off-exchange precious metals transactions, as well as fraud and other violations." In March 2014, a bench trial was concluded against Hunter, "and the parties are awaiting the court’s final judgment."

The CFTC filed an Order (PDF) and settled charges that Capital Market Services, LLC "failed to comply with minimum financial requirements for FCMs and RFEDs." The Order requires CMS " to pay a $275,000 civil monetary penalty and to cease and desist from violating the Commodity Exchange Act and CFTC Regulations, as charged."

Friday, April 4, 2014

According to the complaint (PDF), Walter D. Wagner and Alexander J. Osborn traded on insider information they learned from investment banker, John W. Femenia, "about the impending acquisition of The Shaw Group Inc." Wagner has agreed to a settle the charges by "disgorging his ill-gotten gains plus interest, with any additional financial penalty to be determined by the court at a later date." Criminal charges have also been announced against Wagner. Litigation against Osbern remains pending. Femenia was previously charged in a related insider trading case and has been barred from the securities industry.

The court approved a settlement that requires Rodrigo Terpins and Michel Terpins to pay "nearly $5 million to resolve charges that they were behind suspicious trading in call options of H.J. Heinz Company the day before the company publicly announced its acquisition." The final judgments also permanently enjoin them future violations of the securities laws.

Final judgments were entered against John Kinnucan and his expert consulting firm, Broadband Research Corporation for their alleged involvement in insider trading "involving expert networks." The final judgments permanently enjoin them from future violations of the securities laws, order them to pay over $6.5 million combined in disgorgement, prejudgment interest, and civil penalties.

Former Head of Investment Advisory Firm Sentenced to 63 Months Imprisonment for Conspiracy to Commit Wire Fraud and Making a False Statement to SEC Staff, April 2, 2014, (Litigation Release No. 22962)

This week Fredrick D. Scott was sentenced to 63 months imprisonment, "to be followed by three years of supervised release, and ordered...to pay $1,388,190 in restitution" for allegedly using his "status as a registered investment adviser to bolster his credibility in fraudulently offering too-good-to-be-true investment opportunities." Scott had formerly pled guilty in the case United States v. Scott to "charges of conspiracy to commit wire fraud and making a false statement to SEC staff."

A final judgment has been entered against Alan Sheinwald and his investor relations firm Alliance Advisors LLC for allegedly acting "as unregistered brokers in connection with securities offerings for two companies, including China Yingxia International, Inc." The defendants have consented to the final judgment that permanently enjoins them from future violations of the securities laws, bars them from the securities industry with the right to apply for reentry after two years, bars them from participating in any offering of penny stock, and orders them to pay over $245,000 in disgorgement, prejudgment interest, and civil penalties.

A final judgment was entered against Sheldon Simon for allegedly violating antifraud provisions of the securities laws. The judgment permanently enjoins Simon from future violations of the securities laws and orders him to pay a civil penalty of $3,000. The judge "dismissed the Commission's claims against Simon for disgorgement and prejudgment interest, based on the parallel federal criminal case, where Simon was convicted of wire fraud and sentenced to two years of supervised release, and an order of forfeiture."

District Court Enters Judgment On the Pleadings Against Defendant Stephen F. Molinari, Final Judgment Against Defendant Nationwide Pharmassist Corp., and Order Dismissing Case, April 1, 2014, (Litigation Release No. 22959)

Final judgments were entered against Stephen F. Molinari and Nationwide Pharmassist Corp for their alleged violations of the antifraud provisions of the securities laws. The judgments permanently enjoin them from future violations, impose an officer and director bar and penny stock bar against Molinari, and order Nationwide to pay a $20,000 civil penalty. The Commission's claims against Molinari for disgorgement, prejudgment interest, and a civil penalty were dismissed "based on the parallel criminal case, where Molinari was convicted of mail fraud and sentenced to six months in prison, three years of supervised release, and restitution of $40,000."

Ching Hwa Chen has been charged with trading on insider information "ahead of Informatica Corporation's announcement that it would miss its quarterly earnings target based on confidential information he gleaned from his wife, a tax director at Informatica. His wife had "previously advised Chen not to trade in Informatica securities under any circumstances." Chen realized nearly $140,000 in illicit profits. Chen has agreed to a final judgment that permanently enjoins him from future violations and orders him to pay almost $280,000 in disgorgement, prejudgment interest, and civil penalties.

The SEC charged Tyrone Hawk "with insider trading ahead of Oracle Corporation's acquisition of Acme Packet Inc. based on confidential details he learned from his wife, a finance manager at Oracle." Hawk has agreed to a judgment that permanently enjoins him from future violations of the securities laws and orders him to pay over $305,000 in disgorgement, prejudgment interest, and additional penalties.

Final judgments were entered against Adam Klein, William Keeler, and Jeffrey Richardson for their alleged role in "a massive broker bribery scheme involving the stock of nine public companies, including Syndicated Food Service International, Inc." The judgment permanently enjoins them from future violations, orders them to pay over $700,000 combined in disgorgement and penalties, and imposes a penny stock bar and officer and director bar against Klein.

Judgments were entered against Jeffrey L. Schultz and Redfin Network, Inc. for their alleged violations of the antifraud provisions of the securities laws. The judgments permanently enjoin them from future violations, order Redfin to pay almost $20,000 in disgorgement and prejudgment interest, and impose a penny stock bar and officer and director bar against Schultz. The SEC's claims for disgorgement, prejudgment interest, and a civil penalty were dismissed "based on the parallel federal criminal case, where Schultz was convicted of securities fraud and sentenced to six months in prison, three years of supervised release, and an order of forfeiture."

The SEC has charged Jason A. Halek and Patrick J. Booths of "fraudulently conduct[ing] unregistered securities offerings of working interests in oil and gas projects that were owned and operated by Halek’s company, Halek Energy, LLC." Joshua D. Spivey and Steven J. Little offered these projects "through their separately incorporated companies." The SEC has charged the defendants with violations various provistions of the securities laws and seeks civil penalties, disgorgement, and prejudgment interest. Booths, Spivey, and Little have agreed to be barred from the securities industry as well as barred from participating in the offering of a penny stock and to injunctions against future violations.

The SEC has charged three entities collectively operating under the business names WCM and WCM777 with "rais[ing] more than $65 million since March 2013 by falsely promising tens of thousands of investors that the return on investment in the cloud services venture would be 100 percent or more in 100 days." The entities, which are based "in California and Hong Kong and controlled by 'Phil' Ming Xu," have not used funds as promised but instead have "used investor funds to make Ponzi payments of purported investment returns to some investors...[and] to purchase golf courses and other U.S.-based properties among other unauthorized expenditures." The court has frozen the assets of the businesses, appointed a temporary receiver over the assets, and granted a request for an "order prohibiting the destruction of documents and requiring the defendants to provide accountings." A hearing is scheduled for April 10, 2014.

The CFTC has charged MF Global Inc. with unlawfully "using customer segregated funds to support its own proprietary operations and the operations of its affiliates." The CFTC's consent Order "imposed a $100 million civil monetary penalty on MF Global, to be paid after MF Global has fully paid customers and certain other creditors entitled to priority under bankruptcy law."

Federal Court Orders Two Florida Men and Their Companies to Pay More than $3.3 Million in Restitution and Penalties to Settle Charges Stemming from Role in Illegal, Off-Exchange Precious Metals Transactions, March 31, 2014, (CFTC Press Release No. 6903-14)

Permanent injunction Orders were entered against John King and his company, Newbridge Alliance, Inc. (PDF) and David A. Moore and his company United States Capital Trust, LLC (PDF) for their role "in a multi-million dollar precious metals scheme orchestrated by Hunter Wise Commodities, LLC and related companies." The Orders require the defendants to pay over $3.3 million combined in restitution and civil penalties. "The Orders also impose permanent solicitation, trading and registration bans against King, Newbridge, Moore, and USCT, and prohibit them from further violations of the Commodity Exchange Act and CFTC regulations, as charged."

A final judgment Order (PDF) was entered against Ward Onsa and his company, New Century Investment Management LLC "imposing a civil monetary penalty of almost $6 million against them," imposing permanent trading and registration bans on them, and "prohibiting them from violating the anti-fraud provisions of the Commodity Exchange Act." The judgment stems from CFTC charges that the defendants had conducted "solicitation fraud, misappropriation, and issu[ed] false account statements to commodity pool participants while operating a commodity pool Ponzi scheme." In a related criminal case, U.S. v Ward Onsa, Onsa was sentenced to 78 months imprisonment and ordered to pay over $3.1 million in restitution to victims.

Federal Court Orders St. Augustine, Florida Couple and Their Company to Pay $5.76 Million for Defrauding Customers in Foreign Currency Scheme, March 31, 2014, (CFTC Press Release No. 6900-14)

A supplemental consent Order (PDF) was entered which requires "Gary D. Martin and Brenda K. Martin...and their company, Queen Shoals Consultants, LLC,...to jointly pay a total of $5.76 million in civil monetary penalties for defrauding customers through a retail foreign currency (forex) trading scheme." According to the CFTC, the Martins “'lured customers by claiming QSC and the Martins had a "vast background in financial services" with over 20 years of experience in financial services and a staff of experts ready to assist customers.'" However, the defendants actually "had no expertise or experience in trading forex, and all of the representations concerning trading, guaranteed profits, and profitable accounts were false." Unknown to the investors, the Martins allegedly "turned over all customer funds to Sidney S. Hanson...in return for a referral fee of up to five percent of each customer’s initial and subsequent investment." In 2009, Hanson and other defendants were charged by the CFTC "with operating a Ponzi scheme involving more than $22 million in connection with off-exchange forex trading." Hanson pled guilty to securities fraud and mail fraud in the criminal matter (United States v. Sidney Stanton Hanson)" and "was sentenced on April 1, 2011, to 22 years in prison and ordered to pay $33 million in restitution to victims of the Ponzi scheme."

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